Patterns of international bond issuances : an empirical study of Norwegian firms

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NORGES HANDELSHØYSKOLE 13/07/2010

PATTERNS OF INTERNATIONAL BOND ISSUANCES

AN EMPIRICAL STUDY OF NORWEGIAN FIRMS

By: Tomas Alexander Tveit

MSc Thesis, Major in Financial Economics

Supervisor: Dr Carsten Bienz

This thesis is part of a Master of Science degree in the Economics and Business Administration program at Norges Handelshøyskole – Major in Financial Economics. Neither the institution, nor the advisor – by their approval of this thesis – is responsible for the theories, methods, results or conclusions drawn

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This thesis documents and analyses patterns associated with international bonds issued by Norwegian firms and compares them with patterns of domestic bond issuances. The analysis is focused towards characteristics and features at firm level. The analysis is based on empirical data from the recent period of 1998 – 2008 in order to encourage and guide future research. Three particularly noticeable patterns have been found: (1) The firms which issue bonds internationally have very different characteristics compared to the firms issuing only domestically. Firms issuing internationally have a significantly larger amount of assets, higher profitability, higher level of investment and ability to service debt. (2) Despite the link between firms doing business abroad and issuing bonds abroad, the shipping and fishfarming industries appear to be more attracted to the prominent and renowned features of the Norwegian domestic market. (3) Only 3 of the 25 banks underwriting domestic issues are responsible for underwriting Norwegian bonds internationally. This indicates that the recognition of the underwriter is as important as the recognition of the firm. These findings are then discussed in the light of existing theoretical views.

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It has been difficult to set limits to the chosen topic because of the many interesting and exciting theories and findings connected to the patterns and field of bond issuance. Since it is a topic that has only recently begun to receive focus from the academic community it is hoped that this thesis may contribute to motivate others to research the topic further.

In addition to the appendices, I have enclosed a CD containing the full database with complete spreadsheets and Stata files. Please feel free to contact me for a copy of the data or if you have any questions.

Gathering and putting together the database proved at times to be a daunting challenge, consuming a large part of the limited time available to produce the thesis. Nevertheless, the work laid down in the thesis has provided me with valuable knowledge and, altogether, has been an enriching experience.

I wish to extend special gratitude to the following people:

Dr. Carsten Bienz, Department of Finance and Management Science, NHH, for pointing me in the right direction and giving me good advice.

Svein Lamvik, IT Department, NHH for devoting a good deal of time and effort into securing me access to SDC database.

Preben Stray, DnB Markets’ bond team in Oslo, and Alix Martinelli, Crédit Agricole’s Department for Corporate Origination in Paris, for discussing and offering valuable knowledge on credit ratings and bond issuing processes.

Sally Tveit, Department of Professional and Intercultural Communication, NHH, for proofreading and comments.

Last, but not least, I would like to thank my family for their unwavering support and encouragement.

Bergen, 13.07.2010 --- Tomas Alexander Tveit

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1. INTRODUCTION ... 8

1.1 LIMITATIONS ... 9

1.2 THE STRUCTURE OF THE THESIS ... 10

2. THEORIES – WHAT AFFECTS THE CHOICE OF ISSUANCE? ... 11

2.1 THE LITERATURE ... 11

2.2 MARKET SEGMENTATION VIEW ... 11

2.3 INVESTOR RECOGNITION ... 13

2.4 BONDING VIEW ... 14

2.5 HEDGING CURRENCY RISK ... 17

3. THE NORWEGIAN MARKET ... 19

3.1 HISTORY OF BONDS ... 19

3.2 CENTRAL INDUSTRIES ... 21

3.3 THE GOVERNMENT’S CORPORATE INVOLVEMENT ... 22

3.4 OSLO STOCK EXCHANGE ... 24

3.5 BOND MARKET TODAY ... 25

4. DATA – CONSTRUCTING A DATABASE ... 28

4.1 TIME FRAME ... 28

4.2 CRITERIA FOR FIRMS ... 28

4.3 BOND ISSUANCE DATA ... 29

4.4 DIVIDING INTERNATIONAL AND DOMESTIC ... 29

4.5 FINANCIAL INCOME STATEMENTS ... 30

4.6 OUTLIERS AND CRITERIA FOR OBSERVATIONS ... 30

4.7 EXCHANGE RATES ... 30

4.8 CREDIT RATINGS ... 31

4.9 SPECIFIC DECISIONS AND LIMITATIONS ... 31

4.10 FINAL NUMBER OF OBSERVATIONS AND FIRMS ... 33

4.11 OTHER EMPIRICAL ANALYSES ... 34

4.11.1 “Patterns of international capital raisings”, by Gozzi et al (2010) ... 34

4.11.2 “Why do firms issue global bonds?” by Tawatnuntachai and Yaman (2008) ... 34

5. THE ANALYSIS ... 35

5.1 DESCRIPTIVE PATTERNS OF AGGREGATED BOND ISSUANCES ... 35

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5.2 FIRMS ACCESSING THE INTERNATIONAL MARKET ... 38

5.3 BOND ISSUING PATTERNS SORTED FOR INDUSTRIES ... 40

5.4 CHARACTERISTICS OF FIRMS - WHICH FIRMS ISSUE ABROAD ... 42

5.4.1 Specifics and methods ... 42

5.4.2 Characteristics ... 43

5.4.3 Summing up the most central characteristics ... 49

5.5 CURRENCY EXCHANGE RISK ... 50

5.6 CREDIT RATINGS ... 54

5.7 UNDERWRITERS ... 57

6. DISCUSSION ... 60

6.1 SEGMENTATION VIEW ... 60

6.1.1 National level ... 60

6.1.2 Industrial level ... 61

6.1.3 Firm level ... 62

6.1.4 Summing up ... 63

6.2 INVESTOR RECOGNITION ... 63

6.2.1 Firm and industry specifics ... 64

6.2.2 Credit Ratings ... 65

6.2.3 The use of underwriters ... 65

6.2.4 Summing up ... 66

6.3 BONDING VIEW ... 66

6.3.1 Corporate control ... 67

6.3.2 Private benefits ... 68

6.3.3 Summing up ... 69

6.4 HEDGING CURRENCY RISK ... 70

6.5 SUMMARY OF THE THEORIES ... 71

7. CONCLUSION ... 72

8. APPENDIX ... 74

8.1 LIST OF FIRMS ... 74

8.2 EXCHANGE RATES ... 75

8.3 ISSUING PATTERNS SORTED BY INDUSTRIES ... 75

8.4 HISTORICAL CHANGES IN CREDIT RATINGS OF NORWEGIAN FIRMS ... 76

9. BIBLIOGRAPHY ... 78

9.1WEBSITES REFERENCES: ... 80

9.2SOURCES OF ADDITIONAL DATA INPUT ... 81

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Fig. 1. The development of ownership on the Norwegian Stock exchange. ... 23

Fig. 2. ”Folketrydfondet”’s domestic bond involvement. ... 26

Fig. 3. Investor groups in the Norwegian market. ... 26

Fig. 4. The proportion and number of industries represented in the dataset. ... 33

Fig. 5. Aggregate amount of bonds issued in million NOK. ... 35

Fig. 6. Amount of bonds issues 1998 – 2008 for international (blue) and domestic(red). ... 36

Fig. 7 Number of issues per year for international(blue) and domestic(red). ... 36

Fig. 8 The domestic proportion of issues sorted by industries. ... 40

Fig. 9. The international proportion of issues sorted by industries. ... 41

Fig. 10 The development of currency exchange rates against the NOK. ... 51

Fig. 11. The number of denominated issues in the domestic market sorted by industry and currency. ... 52

Fig. 12. The number of denominated issues in the domestic market sorted by industry and currency. ... 53

Fig. 13. The underwriters managing domestic issued bonds sorted by industry. ... 57

Fig. 14 Underwriters of International bonds sorted by industry. ... 58

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LIST OF TABLES

Table 1. Descriptive statistics of domestic firms’ representation. ... 38

Table 2. Descriptive statistics of international firm set’s representation. ... 39

Table 3. Firm Characteristics. ... 44

Table 4. The number of denominated bonds issued by Norwegian firms in the domestic market sorted by industries and currencies. ... 52

Table 5. Number of denominated bonds issued by Norwegian firms in the International Market, sorted by industries and currencies. ... 54

Table 6. List of the Norwegian firms rated by Standard and Poor. ... 55

Table 7. List of firms comprising the dataset. ... 74

Table 8. USD/NOK exchange rates. Source: Norges Bank ... 75

Table 9. The number of bonds issued in the domestic market sorted by industry and year. ... 75

Table 10. The number of bonds issued in the international market sorted by industry and year ... 76

Table 11 Historcial changes in credit ratings of Norwegian firms... 77

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1. I

Capital markets are the centre stage for firms aiming to raise capital. With the progressive state of globalization, capital markets are constantly evolving by integrating nations and their domestic markets and by creating a larger international marketplace with greater possibilities.

The securities, corporate activity and market dynamics surrounding the new capital markets need to be fully investigated in order to understand how the evolution and patterns of globalization are affecting them.

Because of the ever increasing selection of securities and capital vehicles, the available choices for raising capital are becoming more and more complex. However, studies show that the most utilized and valued way of raising capital is through issuing debt. J.C Gozzi et al (2010) show that approximately 81% of all capital raising is done through debt. 35 % of this is issued abroad. For corporations, the main type of debt is through bonds. While securities bearing status as equity has been a hot topic for a long time, the focus and research around corporate bonds and issuance of debt has surprisingly, to date, been a fairly uncovered topic.

Norway is a small country in the scheme of capital markets, domestic corporate markets and domestic demand. It is not a part of a commonwealth such as the European Union (EU), although it is part of the Schengen Agreement (EØS) which forces it to follow trade

regulations from the EU. It has a large wealth from its oil and natural resources, making it one of the richest countries in terms of wealth per capita. Owing to its small population, the majority of its industries are capital intensive and few are large scale international. However, the firms that are large are world-leaders within their industry. These industries are mainly Oil and Gas, Energy and Utility, and Shipping and Fishfarming.

The aim of this thesis is to research the patterns of bond issuances in the international market by Norwegian firms. The focus is at the firm level, looking specifically for differences between firms issuing bonds abroad, and firms not doing so. In order to obtain a better

understanding of the results, the analysis covers additionally some aggregated patterns as well as surrounding factors which may play a part. Furthermore, the thesis uses theories from recognized literature in order to provide plausible explanations for the patterns.

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1.1 L

Since this is a fairly undocumented area of research there are many interesting aspects which could be examined. Unfortunately, the amount of data accessible within the available time- frame has limited the extent of possible analysis.

The first limitation arose from a natural aspect. Because the Norwegian bonds market is relatively small, especially in terms of international issues, statistical significant results of a full analysis of aggregated patterns are difficult to achieve. This is a common problem for many smaller markets and, in other research, Norway is often placed in accumulated groups because of its small representation. For this reason this thesis has focused on the firm level.

Acquiring available data proved to be more complex than at first anticipated. Obtaining access to or getting hold of historical data such as credit ratings, financial income statements and international bond data required a significant amount of effort. Owing to access problems, some of the data had to be manually retrieved by external consultants and banks. Some data was simply unavailable thus limiting the extent of the analysis. This was especially a problem when trying to get hold of the less recognized firms’ credit ratings.

When determining the direction of the analysis the scale of the project and problems related to accessing and collecting data were important factors. The most central findings in this thesis are the firm characteristics and their coefficients. Ideally it would have been interesting to perform further analysis from this basis. Two possible alternatives were (a) to examine the differences between the firms before and after the first international issuance, or (b) to compare the characteristics of firms issuing equity. Unfortunately, owing to the limited time frame and obstacles in accessing data, these further analyses were deemed too extensive to pursue.

Many of the individual theories which support the theoretical views described in this thesis also illustrate and test the resulting outcome from the presence of these theoretical views. The effects are for example lower yields, higher underwriting prices, etc. This thesis does not aim to prove these effects, but rather acknowledges them. The intention of adding them to the description of the theories is to provide an intuitive explanation of the patterns found in the thesis and to show the importance of uncovering their presence. An overall intention with this

Page | 10 thesis is that the patterns and findings will help to encourage more detailed research on

patterns and effects of Norwegian firms issuing bonds.

1.2 T

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Firstly, relevant theoretical views accumulated from various research publications are presented in Part 2. Most of the articles are published after 2000, and the majority very recently. The theories are therefore up to date and built on recent evidence. These theoretical views provide the basis of the discussion in part 6, where they are linked and matched with the results.

The Norwegian market and background information relating to Norway’s corporate, industrial and bond market features are presented in Part 3. The intention is to give the reader a general awareness of local features and characteristics which are idiosyncratic for the Norwegian market, in order to obtain a better understanding of the analysis and the subsequent reasoning.

Part 4 describes how the database was created, which sources were used and further complications and decisions made prior to the analysis.

The analysis in Part 5 commences with the aggregated level and is followed by the industrial and firm level. The final sections explain the surrounding factors of exchange rates, credit rating and the choice of underwriter.

Part 6 discusses the relation between the existing theoretical views from Part 2 and the analysis results in Part 5.

The conclusions in Part 7 summarize the most important findings of the thesis and plausible explanations.

.

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2. T

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There are several different theories and beliefs as to why companies issue bonds in

international and domestic markets. This analysis does not aim to test or formulate theoretical hypothesizes, but rather to document patterns of issuances and relate them to existing theories that explain them. This part aims therefore to introduce and describe potential theories of what affects the choices of issuance. Potential links between these theories and the patterns found in section 5, will be discussed in section 6.

2.1 T

The literature on raising capital is mostly related to raising equity. However, the processes and mechanisms that exist when issuing equity are fairly similar to those of issuing debt. The theories describing equity are therefore also to some extent compatible and applied for issuing debt.

A large part of the literature directly related to debt issuance tends to focus on the investor’s point of view. The definition of an attractive market for the investor may often be at the expense of the firm, and vice versa. But they have also common interests, and are basically mutually dependent upon each other. The investor wants, and presumably seeks, to invest his free cash flow, and the firm needs to raise capital. In this sense they are financially

complementariness. Intuitively, the theories of the investor’s behavior should therefore to a large extent coincide with the firm’s behavior.

2.2 M

S

The Market Segmentation view is an accumulation of empirical analyses and theories which try to explain potential differences in markets that makes them independent or segmented. It is often linked to various biases and barriers. In a domestic market the possibilities of segmentation may exist as different preferences towards firms listed on the main stock exchange opposed to the alternative OTC exchanges. In international markets there is a wider range of market characteristics that may isolate markets. These may be within macroeconomics, market structures or legal frameworks. The main concept of this view is that the factors driving the segmentation in markets prevent the capital markets in functioning efficiently.

Page | 12 As long as there is trade across markets with that have different jurisdiction, structural distinctions will exist. The question is whether these dissimilarities are significant enough to make a difference. Firms issuing debt in a segmented market may suffer from the restrictions and conditions that limit it. Issuing in a different market may therefore prove to be a better solution of escaping them.

The biases that create segmented markets have a more natural origin. The segmentation through bias leans more towards market clustering of products and interests. This is more of an international trait since an intra-national cluster of similar production would seem fairly normal. They may affect the market in the same ways, but unlike barriers they don’t restrict capital markets. A usual assimilation for this bias is specialization of markets.

The main focus of the literature dedicated to segmentation of capital markets is based on the investor’s point of view. In 1988 the World Bank surveyed 125 institutional investors from 16 different countries with a view to improve debt issuance and trading¹. The survey found that liquidity, investor base and trading convenience were the three most valued attributes. Despite corporations having slightly alternative interests than investors, it seems fairly intuitive that the existence of these attributes also would create a more advantageous arena for firms issuing debt.

Most of the developed countries and markets are known to have fewer investment barriers which help encourage international flow of capital and investors. They are therefore considered to be more integrated. Less developed, small, or emerging markets are, on the other hand, known to have self-imposed barriers such as limits on FDI or tax regulations, as well as barriers caused by lack of legal framework, poor accounting systems and lack of information.

There are different levels of segmentation. This is usually proportionate to how far the country has come in developing their monetary system and economical structure. Factors affecting the risk premium and bond spread may differ between markets. Antzoulatos (2000) found that liquidity has a large impact on determining the emerging market bond spreads. In addition H. Min, Lee, M. Nam, Park and S. Nam (2003) found that liquidity as well as solvency problems determine a great deal of the bond spreads in emerging markets. They also discovered that macroeconomic factors such as inflation rate, terms of trade real

1 “Mobilizing Private Savings for Development: IBRD and the Capital Markets”, by Kenneth G. Lay, 1994

Page | 13 exchange rate, and net foreign assets play a large part in the difference of cross country yield spreads. Being indicators of national risk they affect the creditworthiness related to the country which, in turn, affects the firms. Firms in such countries may, therefore, be subject to increased cost of debt by having to compensate for the risk investors take. Though a portion of investors seek the higher returns that come with these markets, many are often prohibited from accessing them either because of other market barriers, or simply because the risks are too high.

This theory offers two potential reasons for companies looking to issue debt abroad. The first one is to avoid fluctuating legal systems, poor accounting systems, regulations, taxes and illiquid domestic markets which either crave risk premiums for existing investors or simply discourage investors from entering the market. The second is to exploit specialized markets that have investors with the same market or production interests as the firm’s.

2.3 I

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Like any product that needs to be sold, the product or brand’s recognition among buyers is an important attribute. Recognition, or awareness, among buyer and investor will in most cases mean an increase in demand. With an increase in demand, the product may get sold or even achieve a better price. This reasoning also applies to bonds - the investor who is familiar with or recognizes the firm will most likely accept a lower risk premium or compensation, than the investor who doesn’t have any knowledge of the firm.

Another important factor in creating the demand is the pool of investors wanting to invest.

Since bonds are of a certain magnitude, a larger pool of investors is therefore needed to cover the amount issued. For smaller markets, there may be a problem in having a large enough pool of interested investors - especially if the issue size is large. This may force the firm to lower its offering price or increase the yield, which increases the issuers’ cost of debt. An alternative is to issue the bonds in international markets were the pool of investors is large enough to create a sufficient demand and therefore keep the cost of debt down. However, in the international market, smaller firms may not be recognized by the investors, which again would mean an increase the cost of debt, in order to compensate for an increase in perceived risk.

Page | 14 So far the reasoning has been intuitively based on common economic mechanisms. There are several articles that argue and debate the topic on how the firm’s recognition affects the cost associated with issuing debt in multiple or international markets. Merton (1987) argues that the issuing firm’s cost of capital is lower when a larger proportion of the investors recognizes, or is familiar with, the firm and its operations. His argument suggests that large firms that do business in international markets, and are therefore more recognized, may achieve lower cost of capital by issuing in international markets. Puthenpurackal (2001) found that the international issuance’s at-issue yields and underwriting costs are 12 to 15 basis points lower than the domestic issuances. However, Tawatnunchai and Yaman (2008) find that the overall cost of issuing internationally is approximately the same as for domestic firms. They measure the overall cost by adding the indirect costs of change in stock value to the direct costs of the issuance. They do, however, find that the majority of firm that choose to issue abroad, have good reputations

There appears to be are mixed beliefs concerning the total lower cost of issuing in international markets. However, the literature seems to agree that firm recognition and awareness among investors is a vital feature to issuing bonds successfully in the international market.

2.4 B

The bonding view is an accumulation of theories which aim to challenge the ownership, control and governance of the corporations. One theory is that bondholders may be affected by the extent of rules and regulations limiting the open market for corporate control.

Corporate control is meant as the market for takeovers. The idea is that few barriers for corporate control reduces the managerial preference for a “quiet life”, and enhances profitability and firm value. (Bertrand and Mullainathan, 2003). This reasoning assumes that the market for corporate control is a market in which managers compete for the privilege to manage a firm’s resources (Fama, 1980; Jensen and Ruback, 1983). The theory is, however, somewhat unclear as to how bondholders view this governance mechanism. Bondholders may benefit from increase of firm value, but with the change in risk often associated with takeovers, their wealth may go in either direction (Billett, King and Mauer, 2004; Warga and Welch 1993).

Page | 15 From a corporation’s view point, the majority and most recognized capital structure models project maximization of shareholders wealth. However, research increasingly recognizes potential theories and models projecting managers’ self-interest deciding the capital structure.

These do not necessarily coincide with the optimizing of shareholder wealth. Though the self- interest may be related to various issues, the matter of interest here is related to the findings of Garvey and Hanka (1999), which suggested that managers issue debt depending on the protection their firms are subject to. They found that while protected companies reduce their use of debt, unprotected firms do the opposite. This is in-line with the findings of Bertrand and Mullainathan (2003) and supports more recent research suggesting managers use excess debt to avoid the threat of hostile takeovers.

Recently Qiu and Yu (2009) suggested that bondholders react negatively to a restraining of the market for corporate control. This was based on empirical evidence suggesting an increase in cost of debt after the passing of the US’s business combination (BC) laws, which raised the cost of takeovers. This was, however, found only to apply to firms in non- competitive industries, and for firms rated with speculative grade (BB or lower). This would suggest that bondholders are more afraid of the increased risk of bad managerial governance rather than the added risk of leverage-increasing takeovers. This seems a fairly intuitive choice as a potential takeover may offer better results than worsening the managerial governance of a firm already considered to be at a large risk of default.

Another theory which plays a part in the bonding view and which is a contrast to an open market for corporate control, is the effect of having large and controlling owners. The issue is directly linked to the private benefits of control. The meaning of private benefits covers company resources captured by a controlling shareholder and using it to his/her own benefit.

It may range from extensive use of executives’ perks and deviations from “fair” prices of assets, to inside information directly related to the firm’s business.

The controlling party will naturally initiate such extraction when it is difficult to prove.

Private benefits are, therefore, difficult to measure. Dyck and Zingales (2004) use two methods related to the difference in stock values, and the price difference between voting rights and their strategic role. Having a controlling party is a characteristic most often found in less developed economies. The evidence varies therefore a good deal. Dyck and Zingales found that legal and institutional mechanisms play an important part in limiting private benefits – especially tax enforcement and media pressure. This also seems intuitive since the

Page | 16 more developed countries have more experienced and stronger legislation and monitoring of ownership and fraud.

The ownership control’s effect on debt and bonds is well documented. The general factors affected are ratings and yield spread. Bhojraj and Sengupta (2003) documented lower yields and higher ratings for firms with larger institutional ownership. Anderson and Reeb (2003) found that family controlled firms have significant advantage in yield spreads than non-family firms. The reasoning is that families don’t diversify to the same extent, and are therefore more concerned and protective of the firm. More risky projects are therefore more easily turned down, which again reduces the risks related to holding the bonds, and hence a lower yield spread. Furthermore, Ashbaugh et al. (2006) found that firm ratings are negatively related to shareholder rights, CEO also acting as the Chief of the board, and ownership control.

These analyses are all based on the US domestic market and can therefore not be generalized for other markets. They do, though, represent plausible theories.

Recently Boubakri and Ghouma (2010) tested a hypothesis of whether ultimate owners with voting rights and cash-flow rights would threaten the interest of bondholders through investing in less or non-profitable projects. Using a mixture of developed and developing markets, their evidence showed that family control gives a increasing effect on bond yields and a negative effect on ratings. This is contradictory to the findings of Anderson and Reeb (2003). Boubakri and Ghouma (2010) also found that control of widely held financial firms only has an effect on the ratings, while State control has no effect on either of the two. Their reasoning was that families in controlling positions are more likely to extract private benefits that harm the debt holders’ interest. Also, since the owners are less likely to dilute their control when raising capital, they are more likely to use debt financing.

Their analysis also tested the effect of investor protection on debt and bonds. They showed that better bondholder protection generally reduces the bond yields and increases corporate bond ratings. This is in line with the findings of Dyck and Zingales (2004) which have been mentioned earlier. However, Boubakri and Ghouma (2010) went even further and suggested that the protection is related to the enforcement of debt law being more important than simply the existence of book law. In effect, their conclusion runs in favor of issuing in more developed countries which tend to have more controlling agencies and institutions.

Page | 17 A solution often appearing in the bonding view’s theories, is to issue internationally. One idea suggests issuing debt in foreign markets and internationalizing as a way for firms to bind themselves to better corporate governance frameworks, which theoretically increases the firm’s protection against corporate takeovers. Another suggests that issuing abroad in more developed markets should lessen the fear of insufficient legal protection for the bondholders.

The potential outcomes are shortly summarized as; limitation of negative effects on bondholder’s risk and wealth, inefficient governance, and exploitation of private benefits that otherwise would increase the cost of debt for the corporation and bondholders.

2.5 H

C

If a company receives cash flows or income in different currencies than their domestic currency, they are exposed to exchange rate risk. A common way to deal with this is to issue debt in foreign markets and or denominated in the currencies which they expect to receive the cash flows and income in. This is a method called straight hedging, and offsets the risk of a fluctuating value of the underlying. Another alternative is cross-hedging, which implies that the firm issues debt denominated in currencies that is correlated with the underlying cash flow’s currency. When hedging with debt, it is important to notice that issuing debt only provides a suitable hedge for revenues. For many firms that do business abroad, an equally important factor is the costs that materialize. Issuing debt to hedge the cost, however, only increases the exposure towards the currency rather than decrease it.

Kedia and Mozumdar (2003) found strong evidence that debt issuance in foreign currency is related to foreign activity. Furthermore, they showed that the significance of this factor is consistent with foreign debt playing the role as a hedging instrument. In the results they found evidence of both straight and cross hedging. Also Elliott, Huffmann and Makar (2003) found a strong relationship between the exposure to foreign currency and the level of foreign- denominated debt for US multinational firms. Additionally, they found that the foreign denominated debt is negatively correlated with foreign denominated derivates. This supports the evidence that the debt is used for hedging purposes.

Firms that have international relations, either through production, export or investments abroad are known to hedge their cash flows denominated in foreign currency. The method of hedging cash flows and income has through times varied somewhat, owing to different types of financial vehicles evolving and a constantly increasing globalization of business. Elliott,

Page | 18 Huffmann and Makar (2003) find that due to a large quantity of derivatives used in the end of the century, foreign denominated debt is increasing as the popular vehicle to hedge with. But hedging the cash flows with bonds in a foreign denominated currency does not dictate the choice of market. The currency market is like most other capital markets globalizing at and equally fast pace. In large marketplaces like London Stock Exchange and NASDAQ, it is common that firms issue bonds denominated in a wide variety of currencies. The most common bonds are the individual Eurobonds, and Global bonds that have multiple currencies.²

2 Tawatnuntachai and Yaman, “why do firms issue global bonds” (2008)

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3. T

N

Norway is both a small and a fairly young nation in the world market. It does, however, have several distinctive features that make it different from other nations. Starting off by going back to the first issued bond should help to emphasize the importance of government involvement in the corporate ownership and governance. This part aims to give an overall illustration of the Norwegian industries, bond market and the government’s role in the corporate market.

3.1 H

The first bond issued in Norway was by the Norwegian state in 1820, six years after the country’s independence. It was issued in Berlin, but owing to high interest and administration costs, it was regarded as a national disgrace. Most bonds between this period and WWI were either issued by the Norwegian government or by the state bank, Kongeriket Norges Hypotekbank, which was established in 1851. Until 1920 the bonds issued were mainly characterized by extremely long-term maturity lasting 20 – 60 years. Most of the government bonds were issued on European markets, while the Hypotekbank issued most of its bonds on the domestic stock exchange in Oslo. In the pre-WWI period money was pegged to the metals silver and gold. This meant that there was relatively low or no volatility between currencies³. Government bonds were therefore issued in multi-currencies. The coupons of bonds denominated in Norwegian Kroner from the Hypotekbank were also paid out in Swedish and Danish Kroner. The bond markets in Europe were thriving, with a second-hand market much larger and more liquid than the issue market. The mean yield differentials for Norwegian bonds in Europe were very low, indicating trends today associated with an efficient market.

Europe was therefore considered as one market.

During the period between the world wars a lot changed in the bond markets which caused increased fluctuations in the currency exchange rates. This implied that the multicurrency bonds issued by the Norwegian government had different yields and prices depending on currency. Bondholders wanted their coupons to be in appreciated currencies, thus creating arbitrage situations. In the 1930’s a new legislation was introduced which prevented the flow

3 Chapter 4, “bond markets and bond yields in Norway”, Jan T.Klovland, Norges-Bank.no, referenced; Feb 2010

Page | 20 of bond capital across borders. This made the strong international bond market turn more towards domestic issuances. Government bonds soon dominated the Oslo Stock Exchange and were denominated in NOK.⁴ It was also in this period that the Norwegian market first started attracting private corporate bonds. Initially they started off small, financing building projects and mortgage loans. As they proved successful the issuances increased both in amount and size.

WWII caused the bond market activity in Norway to shrink noticeably. Most of the remaining bonds issued were the government’s bonds financing the Wehrmacht claims.

The period from the end of WWII until 1979 was dominated by the ruling and regulations of the authorities. The interest rate started at 2.5 percent in 1946 when the newly issued bonds were basically controlled for both amount and price. Despite increasing market pressure the interest rate was administratively fixed, only changing 6 times up until 1979⁵. There were, however, certain changes in this period especially concerning the corporate bonds. The credit enterprises experienced a large increase in activity and, despite quotas restricting their bond financing, these institutions consolidated their importance. Also, the government approved the first industrial companies to issue bonds. These approvals were mainly granted for purposes that were favoured by the authorities – mainly export-orientated manufacturing companies or projects associated with electricity.

In 1980 the government turned on their strict monetary policies and started a deregulation process of credit markets. The bond market was largely affected by dismantling control of new issues and bond investment requirements for financial intermediaries. At the end of the decade the control measures were removed from the market and returned to the normality of 50 years earlier⁶.

The reaction led to many new issues driven by both credit enterprises and private industrial companies. The issues were often small, which resulted in infrequent trading once released on the second-hand market. With the market regulations normalized and credit flowing more

4 Chapter 5 – “three busts and booms involving banking crisis in Norway”, Karsten R. Gerdup Norges-bank.no referenced; Feb 2010

5 Chapter 4, “bond markets and bond yields in Norway”, Jan T.Klovland, Norges-Bank.no, referenced; Feb 2010

6 “Shaken or Stirred? Financial Deregulation and the Monetary Transmission in Norway”, G.Bårdsen and Jan T.

Klovland,(2000)

Page | 21 freely and rapidly, the loan portfolios eventually revealed a lot of bad loans. Restructuring the debt became a problem, causing failure for many lead credit enterprises. Many of the survivors ended up with bad credit ratings. On the industrial side, the stock market crash of 1989 became a worldwide phenomenon affecting Norwegian industry which was very dependent on export. With the high interest rates starting to fall at the end of the 1980’s, many bond issues were called. From 1990 there was a vast reduction in private bond issues to just above 20 for credit enterprises and 10 for industrials⁷.

3.2 C

Most of Norway’s wealth comes from exports and imports, where the main export products are refined primary resources. On the top of the list is the export of oil and gas. Discovered in the late 1960s, oil and gas gave Norway a large boost in its economy and development. Most of the oil and gas extracted from the Norwegian reservoirs is exported. In 2010 it accounts for 50% of all exports and 34% of the government’s revenues. Norway is also the fifth largest provider of oil and the third largest of gas in the world⁸. The experience and technology which followed the extraction has also given rise to the growth and development of Norwegian companies in the supporting fields of oil extraction such as oil exploration, subsea operations and drilling.

Norway is one of the world’s leading countries when it comes to hydroelectric power. It produces in total 4 times the amount of energy it needs⁹, with hydroelectric power covering almost the whole domestic demand. Because the production of hydropower cannot be stored, it has a seasonal trend for both consumption and production. However, the net export is normally positive, with European countries as the main buyers¹⁰. The dams and waterways experienced a building boom in the late 1980s and early 1990s. Since then the expansion has been strictly regulated. These dams and hydro plants are in most cases owned by the local government, but governed as individual firms¹¹.

Norwegian Shipping has its roots all the way back to the Viking Age. Having been among the leading countries in innovating ship technology and maritime law, Norway is today major

7 Chapter 4,” bond markets and bond yields in Norway”, Jan T.Klovland, Norges-Bank.no, referenced; Feb 2010

8 www.State.gov, April 2010

9 Source: Tour of StatoilHydro’s Oil and Gas plant at Mongstad, 2006

10 Statnett.no, April 2010

11 Regjeringen.no, April 2010.

Page | 22 league player in the international market. The figures for 2001 show that the Norwegian shipping industry was the 3^rd largest shipping nation in the world, and transporting 10% of the world’s tonnage.¹². This is also an industry where the firms have been founded by entrepreneurs and families rather than the government. It is also one of the larger industries in Norway that is not based on primary resources.

Norwegian salmon is the country’s second largest export product. Norway is a world leader in fishery and fishfarming. Like shipping, this is also an industry mainly built by entrepreneurs rather than the government.

3.3 T

’

At first, Norway was mainly dominated by the primary sectors and the general population was poor. Because of this, the government has played a significant role in developing the nation’s business market and wealth. Lacking both prosperity and current resources, Norway was forced into the bonds market early, as already mentioned in section 3.1. It was, therefore, quite some time before secondary and tertiary sectors, being more capital intensive, became central contributors of GDP.

Norwegian law states that an array of natural resources originating from Norwegian territory belongs to the government, and hence the common wealth of the Norwegian people.¹³ At the beginning of the 20^th century some of the wealthier families and merchants invested more significantly in business and created some of the larger corporations still existing today, such as Orkla, GC Rieber and Norsk Hydro. Except for Norsk Hydro, none of them extracted natural resources. Investing in the areas covered by the laws related to extraction of resources was dominated mainly by the government. This was not, however, unexpected. The law stated that any excess return made on the resources would pass to the state. The initial and investment costs were also extremely high. Many state-owned companies such as Norske Skogsindustrier, Statoil, Statkraft and local energy companies related to hydropower are examples of this. Apart from the corporations within natural resources, the state was also founder of amongst others Telenor, Kongsberg Gruppen and partially SAS.

12 Regjeringen.no, June 2010.

13 lovdata.no, Lov om erverv av vannfall og bergverk kapittel 1§1, and ”Lov om undersjøiske naturforekomster”

§2, June 2010.

Page | 23 The revolutionizing discovery of oil in the North Sea gave Norway a large upswing in wealth.

As well as Statoil growing to become one of the world’s larger oil companies, the gains from taxes and royals from the oil was transferred to a sovereign fund, today called the

“Oljefondet”. One of its investment strategies is to serve the Norwegian society as much as possible through investing in Norwegian companies.¹⁴ It must be noted that, though the fund is owned by the state, the ownership does not affect the governance or investments beyond the guidelines originally state in the fund’s purpose. This will be described in more detail later.

By the beginning of the 21^st century the more liberal parliament decided that some state companies were starting to get so large that they were best governed as individual entities.

Among the more known corporations affected were Statoil and Telenor. The new corporate structures had state-owned majorities of between 53% -68% with 32% - 49% publicly listed and the state assuming a more passive governance role. ¹⁵ This is also expressed in figure 1, where the green line does a sharp turn up 10% in 2001. The increase is due to the government owning large stakes in the newly listed large firms.

Fig. 1. The development of ownership on the Norwegian Stock exchange. The figure shows the proportions of ownership in firms on Oslo Børs. Green: Central and local government, orange: Foreign investors, blue: private firms, pink: private investors, purple: mutual funds, grey: others. Source:VPS

Since 1990’s and up until today the Norwegian government holds large positions in a lot of Norwegian listed companies. Examples are Norske Hydro, Yara International, Aker and Orkla. The government generally keeps a semi-passive ownership where they do not issue any specific security backing, nor do they directly affect the governance of the companies. Their involvement is mostly in terms of expressing expectations related to topics such as business moral issues and in ways of protecting Norwegian interests. This is also how they relate to the sovereign funds, which act as normal investors, but with guidelines.

14 “Petroleum economics: issues and strategies of oil and natural gas production”, Rögnvaldur Hannesson

15 Regjeringen.no, ”Eierskap av Statoil og fremtidig forvaltning av SDØE” March 2010, and Stortinget.no, ”4.Delprivatisering og børsnotering av Telenor”

Page | 24 Of the small amount of research that has been committed to discovering patterns in capital raising through debt, most of it has been towards the more liberal US and British markets.

Both countries have quite different politics and constitutional frameworks from Norway. US corporations are dominated by private or public ownership, and post-Thatcher Britain has many of the same features.

This section tries primarily to illustrate that the level of privatization in Norwegian corporations cannot be compared in full with the more open markets. While discarding firms due to state involvement does not largely affect the outcome in US, UK or other more liberal countries, discarding the same firms in Norway would drastically reduce the already small number of issuing firms. However, as long as the government only plays a passive ownership role in the firms, either through their own directives or through sovereign funds, the findings on firms in Norway may realistically be compared to other benchmarked countries.

3.4 O

Oslo Børs is the only Norwegian stock exchange where bonds are listed and traded. It is a small stock exchange in comparison to many of the large bourses and stock exchanges in Europe and the world. It holds a substantial selection of firms covering a considerable variety of sectors, and is often referred to as a stock exchange for commodities. However, over 50%

of them are related to either Energy or Oil and Gas. It is also the world’s leading stock exchange for the fish-farming industry, as well as holding a large number of the world’s shipping bonds¹⁶.

In order to attract a larger investor base and make Norwegian stocks and bonds more accessible, the stock exchange cooperates with the London Stock Exchange Group (LSEG).

This cooperation is fairly new (2009), and is a replacement of the previous contract with NASDAQ OMX. Through these networks the Oslo Børs shares members and trading systems with several other stock exchanges around the world. Oslo Børs has today 57 members, where 33 of them are of international origin¹⁷. This shows the importance of the role which foreign investors play on the Norwegian market.

16 Oslobors.no May 2010

17 Oslobørs.no May 2010

Page | 25 The traditional section of Oslo Børs is required to follow all directives from the European Commission (EC) owing to the agreement of European Economic Area (EEA). In 2006, the EC put new directives into effect requiring listed firms in Norway to use IFRS in their consolidated accounts¹⁸. As a reaction to this, Oslo Børs established the Alternative Bond Market, ABM, in 2005. This functioned as an unofficial market place organized and administrated by Oslo Børs in order to avoid the strict rules of the EC. In other words, it functioned like the traditional exchange, but adopted simplified application process and prospectus regulations¹⁹.

3.5 B

The Norwegian corporate bond market follows two main benchmarks for the domestic market. The first benchmark is the government bonds. With its large wealth as its backing, Norwegian government bonds are rated top of the class at all rating bureaus, and serves therefore as the benchmark for risk free investments. The second is the Nordic interbank offered rate, NIBOR, which projects the interbank rate on loans in the Nordic region. In terms of credit default swap rates there are only the iTraxx indices that cover Europe and Asia. They operate either as total market indices or specifically on industries. These second hand market rates do, to some extent, affect the issuing market. However, the iTraxx has Telenor as the only Norwegian firm, and has therefore a minimalistic influence on the domestic market.

In order to set the correct price or yield on any bond being issued, the market must be large enough to be able to supply a sufficient amount of liquidity. This is a problem in Norway, as it is relatively small market. Compared to its neighbours, Sweden and Denmark are considered twice and four times larger, respectively. In an attempt to increase the liquidity, many of the government’s sovereign funds, such as “Folketrygdsfondet”, “Oljefondet” and

“Pensjonsfondet” have instructions to do a certain amount of investments in the domestic market. An important feature in this strategy is that the funds are independent of the government and aims therefore to maximize their profits like any other investor. The fund

“Folketrygdfondet” is one of the largest funds, holding 4.9 % of the total domestic

18 Estandardsforum.org/Norway/ May 2010

19 Osloabm.no, May 2010

Page | 26 bondmarket. They hold 3.1% of the total corporate market, excluding the financial sector²⁰. Figure 2 illustrates the proportion of bonds the fund holds.

Historically, there are very few incidents of issuers defaulting on their debt. Despite this, only a minimum of the bonds issued are rated by the recognized rating agencies of Standard and Poor, Moody’s and Fitch. In fact, there are so few, that many databases choose not to collect the data on ratings. For international investors, portfolio managers and hedge fund managers that base large parts of their analysis on ratings, only a few firms stand a chance of being included in the portfolios. A normal assumption among investment banks is that if the firm or bond is not rated by Standard and poor, or Moody’s, it is considered non-rated²¹. There are, however, some smaller agencies and banks that rate Norwegian firms. DnB NOR, Nordea and

Dun & Bradstreet all produce ratings for the Norwegian market, but are less recognized and are often subjected to criticism for having a conflict of interest. For the banks, the ratings are largely used for their own and their clients’ use. Fortunately for the firms issuing bonds, investors don’t only look at ratings. As described under section 3.2, the Oslo bourse has a large proportion of international investment banks and investors, despite the few ratings²². Figure 3 illustrates the proportion of investor groups in the domestic market.

20 Ftf.no, ”det norske obligasjonsmarkedet” 2009.

21 Source; DCM contact at Credit Agricole, Paris.

9 Ftf.no, ”det norske obligasjonsmarkedet” 2009

Fig. 2. Investor groups in the Norwegian market.

Source: nftf.no, VPS.

Fig. 3. ”Folketrydfondet”’s domestic bond involvement.

Illustrates the proportion in which the Sovereign fund has invested in the Norwegian bond market. Source:

nftf.no, VPS

Page | 27 Norway and Norwegian bonds are ranked with the highest score for creditworthiness²³. Every aspect of risk is calculated into the ratings of firms, including sovereign risk. With a national risk assessment at the top of the class, the ratings of Norwegian firms are therefore more affected by the industry and their own actions and business.

23 Euromoney.com Bi-annual survey which monitors the political and economic stability of 185 sovereign countries, according to ratings agencies and market experts. 2010

Page | 28

4. D

– C

Databases normally collect and hold only a limited array of data types. Being a small country, Norway is not noticeably represented in international databases and Norway’s own databases are fairly specialized and dedicated. The main categories of data tested in this thesis are related to bond issuances - both domestically and abroad, and to firm characteristics from financial income statements, currency rates, market indices and stock market values.

This part aims to illustrate and describe the origin, criteria, characteristics, experienced problems and decisions made on the applied dataset. This part ends with a description of the literary sources for methods and empirical data with which the results in the analysis are compared.

4.1 T

The timeframe of the analysis is set to 1998 – 2008, and includes only bonds issued in this period. This is in line with the intention of the thesis giving an empirical analysis based on recent historical activity. In addition, there were limitations on the available data from financial statements before 1998, and most Annual Reports for 2009 were not published at the time. A ten year aspect should suffice to empirically characterize the activity and patterns of today’s market. There have been both booms and busts in this period, and Norway was especially affected by the bank crisis of 2002-2003 and the recent international financial crisis of 2008.

4.2 C

There are many firms and institutions that can issue bonds with various intentions and to cover different financing needs. Since this thesis focuses on the corporate bond market, the selection of bonds must be limited to firms that are somehow listed in the public market. This initially rules out all bonds issued by national, regional and local government and government agencies. However, there have been made some exceptions owing to the positions and structure in the corporate ownership, which was explain in section 3.3.

Investment institutions such as banks and funds, credit institutions and other real estate trusts as well as bonds that are mortgage-backed or other asset-backed were excluded from the dataset.

Page | 29

4.3 B

The data on bond issuance in Norway is collected from the database of Norwegian Trustee Service, and covers all issuances registered with the Norwegian Central Securities Depository, VPS. Norwegian companies are, by law, obliged to report any issuance of bonds to VPS.

This law was put into action 1996, and applies therefore for the whole of the thesis’ time frame. Hence, the database should hold all domestic issues.

The law obliging firms to report bond issuances does not apply for issuances in foreign markets. The data on international bond issues comes therefore from Thompson Reuters’

Security Data Corporation’s (SDC) New Issues Database. The database provides transaction- level information on new issues of bonds with an original maturity longer than 1 year. For these reasons the dataset does not include debt with maturities shorter than this.

The criteria for the data in SDC are Norwegian domicile, and exclusion of the macro industries Finance and Government. The search also excludes the bonds that are meant for the domestic market. There are also a fair amount of issuances listed in the domestic markets but which are denominated in foreign currencies. The bond data holds both public and private issues, convertible and non-convertible bonds, and fixed and floating rated bonds.

4.4 D

I

Many of the domestic issues state that the target market is both Norway and Europe. Since bonds are listed in Norway and in the VPS, they are considered domestic issuances. Among the firms issuing debt abroad, a large portion also issue debt domestically. These firms are regarded as international issuing firms, and are not included in the domestic dataset, and therefore do not affect the patterns of the domestic issuers. By doing so the results will illustrate patterns for firms only issuing debt domestically, opposed to the firms issuing internationally. When it comes to subsidiaries and companies wholly or partially owned by Norwegian firms, they are considered independent firms. This is intuitive since the subsidiaries have separate management and accounts. Some of these are also of foreign origin.

Examples are Kyvistar and Norske Skogsindustrier Canada. These are considered foreign firms, and therefore fail to meet the criteria for the Norwegian based dataset.

Page | 30

4.5 F

The firm level characteristics and figures form the largest dataset in the thesis. The main source for this data was the Bourse project from NHH. Though the database is mainly concentrated on stock and bond prices and indices from Oslo Stock Exchange, OSE, it also recently added the function of serving financial income data. The Financial income data covers all companies listed on the OSE. A problem was that many of the firms issuing bonds are small or medium firms not registered on the OSE. These are mostly firms that are traded OTC, and list their bonds on the Oslo Alternative bond market, ABM. As described earlier, this marketplace is an unofficial market place, and clears both EU directives regarding IFRS requirements. The result was a large quantity of missing data on several firms. So as not to lose any valuable observations, the missing values were filled in by acquiring the data from the databases of proff.no, ravninfo.no and published reports on various firm websites.

Unfortunately, there were firms that still had significantly large amounts of data missing.

These few firms were along with their bond data excluded from the data set.

4.6 O

Some of the industries in the dataset exposed to extreme and fluctuating capital intensiveness.

A normalized cash flow may prove hard to sustain, which means the financial statements and key ratios fluctuate considerably. For example, the initial investment costs of oil exploration are very high. At the same time, the income is often connected to completion of contracts and projects, meaning that the time of income may be uncertain and arrive in large batches. For the dataset this means a large case of outliers and sudden changes. Normally, outliers would be removed so that the regression would not be biased by the observations. The Norwegian market, on the other hand, is especially exposed to industries with these characteristics.

Removing outliers, and with it valuable information, would give a more unbiased mean. Since this is considered a normal property of the market, it is therefore appropriate to use the median as a more representative coefficient. Hence the effect of outliers is reduced and the information is still implemented into the analysis.

4.7 E

Some of the financial income data is stated in US dollars, USD. Also the bonds issued abroad are denominated in foreign currencies. The SDC database which holds this information also

Page | 31 states the principal or tranche amount of the issue in USD. To be able to compare the amounts with domestic amounts in Norwegian Kroner, NOK, the USD is converted to NOK by the historic, daily averaged exchange rate given by the Central Bank of Norway. The list is found in Appendix 8.2

4.8 C

R

Credit Ratings are an important part of the everyday bond market. The ratings of Standard and Poor, Moody’s and Fitch are fairly available through the SDC database used for international bond data. Historical credit ratings were, however, not easily available. The historical data used in the thesis, was found through access to a Bloomberg terminal. The choice of using Standard and Poor as the international agency was merely based on available data. The firms rated by S&P were also checked towards the ratings of Moody’s and Fitch. The result showed that they had the same firms and ratings.

Unfortunately, acquiring the historical ratings from the less recognized rating agencies of Dun

& Bradstreet and DnB NOR, required too much extensive work from the agencies and the data therefore became inaccessible to the thesis.

Since there were very few observations of the Norwegian firm, the analysis was based on the few observations available and conversations with the bond departments at DnB NOR in Oslo and Credit Agricolé in Paris.

4.9 S

With the data from different sources over a ten year period, there were certain issues that needed to be addressed and decided upon. This section will quickly describe some of the limitations and decisions made in creating the dataset.

Capex

Capital expenditure is defined as expenditures that create future benefits. It is a good and widely used coefficient to represent the level of investment in a company. This figure is usually stated in the cash flow statement. However, this was not available for the majority of the firms. So as not to discard the Capex and the information it holds, the alternative was to calculate it instead using the following equation: